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Emerging Giants: The Chinese and Indian Economies in Comparative Perspective

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The market-oriented economic reforms that started in 1978 have greatly transformed the Chinese economy. State-owned enterprises (SOEs) were allowed to operate and compete on free market principles, rather than under the direction and guidance of state planning; special economic zones were established along the coast for the purpose of attracting foreign direct investments, boosting exports, and importing high-technology products; and, private enterprises were legalized and promoted. With these reforms, the average annual growth rate of China’s real GDP was close to 10 percent from 1979 to 2007, compared to a prereform growth rate of around 5 percent from 1960 to 1978. No country has ever lifted more people out of poverty faster than China since the adoption of these reforms. However, economic growth in China has been accompanied by severe environmental deterioration.

According to The Economist (2004), the World Bank estimates that direct damages from pollution (e.g. medical bills) are 8–12 percent of China’s annual GDP. The World Bank has identified 16 of the 20 most polluted cities in the world to be located in China. And close to two-thirds of the 300 cities tested by China’s environmental protection agency failed to meet the air quality standards set by the World Health Organization. With negligent environmental protection, some areas have such high levels of toxins in the air and groundwater that cancer levels are 15 to 30 times higher than the national figure (see Lynch 2005).1 Unsustainable environmental practices also pose increasing threats to China’s water, forests, biodiversity, and food and energy supplies. Since China is a huge country, its pollution problems undoubtedly have serious negative effects on the global environment.2

Currently, forces that oppose more stringent rules and regulations in the name of free markets and economic growth are battling forces that favor greater environmental protection. It appears that the latter group is losing the battle. The general public and the central government tend to favor more stringent environmental rules while local governments do not.3 The current central and local government tax revenue sharing scheme is one reason why local governments in China have little incentive to call for more stringent environmental policies. Since 1994, local governments have experienced budget deficits every year, and they have come to rely heavily on central government transfers.4 These transfers are largely dependent on value-added tax rebates. Since value-added tax rebates are related to local output increases, local governments in China have strong incentives to increase production (thereby increasing revenue transfers),5 but have little incentive to protect the environment.

In this chapter, we revisit the environmental Kuznets curve (EKC) hypothesis. According to the EKC hypothesis, an inverted-U characterizes the income-emission relationship.6 However, a number of studies (e.g. Millimet et al. 2003) have shown that a cubic relationship may exist between income and emissions. In particular, they may again be positively correlated at still higher income levels.

Our strategy is to first estimate income-emissions regressions using fixed effects panel regression using data for 30 Chinese provinces from 1987 to 1995.7 We end the data coverage of the estimations in 1995 since a number of amendments to pollution laws were introduced after this year. This allows us to determine the trajectory of selected pollutants relative to income after 1995 if no changes to pollution policy occur (or, if no changes to the structure of the economy occur). In other words, we make off-sample predictions of pollution discharges using the estimated income-emissions regressions. We then compare these off-sample predictions to actual pollution discharges in 1996 to 2004 to partly quantify any effect pollution policy changes may have had on emissions.

A comparison of the off-sample predictions to actual pollution discharges in 1996 to 2004 indicates that actual industrial chemical oxygen demand (COD) pollution per capita discharge rates in 1996–2004 have leveled off and do not increase with income as the estimated incomeemission regression predicts. Thus, environmental policies enacted by the Chinese government to control industrial COD pollution may have been partly successful. However, actual industrial waste water per capita discharge rates in 1996–2004 increase with income; this is opposite to the prediction of the estimated income-emission regression. Also, actual industrial dust per capita discharge rates in 1996–2004 are larger than the predicted per capita discharge rates for most of the provinces. This is inconsistent with the notion that given the adoption of stricter environmental regulations, actual emissions should be lower than the predictions because the latter assumes no changes in environmental regulations.

Auxiliary regressions of the estimated province-specific fixed effects against several province characteristics show that conditional on income, northern provinces have lower levels of industrial waste water pollution (thus, may have been more willing to regulate this type of pollution); non-coastal provinces and provinces with smaller secondary industry shares have lower levels of three types of pollutants; provinces with a smaller state-owned enterprises share have lower levels of industrial COD pollution; finally, there is some evidence that a province’s industrial dust pollution level (thus, its commitment to control pollution) is related to its budget balance.

To put the current study in perspective, the environmental consequences of economic growth and policy responses to environmental problems since the establishment of the People’s Republic of China are briefly described in the next section. In Section 9.3 a detailed description of the data and empirical methodology used is provided. The results are analyzed in Section 9.4. Concluding remarks are presented in the last section.


pp. 281-306, “Pollution Across Chinese Provinces,” by Co, Catherine Y.; Kong, Fanying; and Lin, Shuanglin. in Barry Eichengreen, Poonam Gupta, and Rajiv Kumar, eds., in Emerging Giants: The Chinese and Indian Economies in Comparative Perspective, 2010, reproduced by permission of Oxford University Press